Republicans grapple over corporate tax reform without hurting small businesses

Small businesses have become the crux of the tax reform debate, with Republicans saying it makes no sense to do only a corporate overhaul because it will leave behind millions of mom-and-pop shops that file their taxes as individuals.

Under current law, small businesses that file as individuals end up at a disadvantage, House Speaker Paul D. Ryan, Wisconsin Republican, said Wednesday as he toured Accel Inc., a packaging company in New Albany, Ohio.

The U.S. corporate tax rate is 35 percent — much higher than the worldwide average of 23 percent — but small businesses such as Accel that file as “subchapter S corporations” can pay even higher individual rates.

“The top tax rate on subchapter S corporations in America — which is eight out of 10 businesses in America — their top tax rate’s 44.6 percent,” Mr. Ryan said. “You throw the Ohio income tax on top of that or the Wisconsin income tax, and we are taxing businesses, employers, jobs more than 50 percent in many cases.”

Republicans are trying to build momentum for their push for tax reform, knowing they will get little help from Democrats.

Efforts to find common ground with President Obama on corporate taxes went nowhere, but with total control of the levers of Washington, Republicans are aiming even bigger now, saying both sides of the tax code can be overhauled to the benefit of everyone.

“How can we compete with the likes of all the rest of the world when we tax our job creators and our employers at much, much higher tax rates than our competitors tax theirs?” Mr. Ryan said.

“This is why we’ve got to get tax reform,” he said. “This is why we have to look at this once-in-a-lifetime opportunity to get fundamental tax reform.”

House Republicans introduced a tax reform blueprint last year that called for lowering the top individual rate from 39.6 percent to 33 percent and for cutting the corporate rate to 20 percent.

The House plan would make up for the lost revenue in part by eliminating deductions such as the write-offs on state and local income taxes, though it would retain the popular deductions for mortgage interest and charitable contributions.

Last month, the White House issued its outline, which proposes cutting the top individual rate to 35 percent and slashing the corporate rate to 15 percent.

Democrats say that eliminating items such as the deductions for state and local taxes hurts the middle class and that wealthier people who don’t need the tax cut will try to exploit the system if the 15 percent rate ends up being applied to the smaller companies that file individually.

Some conservatives say Republicans should go for a corporate and small-business tax cut only to give the economy a jump-start before overhauling the individual income tax system.

Treasury Secretary Steven T. Mnuchin has said that economic growth would pay for a lot of the plan, and congressional Republicans likewise have argued that lowering the corporate rate would jump-start the economy and result in a broader tax base to lift the revenue side.

But such “pass-through” entities have to be included as part of tax reform for both political and economic reasons, as addressing smaller businesses without also addressing individual rates could create problems, said David Burton, a senior fellow in economic policy at The Heritage Foundation.

“If you drop the rate for pass-through entities and not for individual taxpayers, once the differential becomes too large, people will start trying to re-characterize employment income as pass-through income,” Mr. Burton said. “And that’s a challenging problem to police.”

The Tax Foundation says pass-through companies accounted for 91 percent of private businesses in the U.S. and employed 73 million people in 2014, and earned $1.63 trillion in net income in 2012, compared with 54.3 million employed by the more traditional “C” corporations, with net earnings of $1.1 trillion.

Even though pass-through businesses face a higher top rate, one advantage to filing that way is that their profits are taxed only once, as opposed to larger corporations that face a “double taxation” of the initial corporate tax and again on dividends or capital gains, according to the Tax Foundation.

Grover Norquist, president of Americans for Tax Reform, said Wednesday that all sides need to be tackled at once because small businesses have long been nervous about getting lost in the shuffle.

“The small business community is very concerned [and] were panicked during the Obama years that they would get left out because Obama hates them and that somehow they would be promised, ‘We’ll do you next,’ and then Hillary wins,” Mr. Norquist said. “It needs to be done at the same time.”

The House Republican tax blueprint calls for lowering the rate for subchapter S companies to a maximum of 25 percent.

The White House, meanwhile, has offered an outline that includes a 15 percent rate that would apply to such smaller businesses.

Mr. Ryan said Wednesday that he is on the same page overall with the principles President Trump has outlined, though House Republicans also have included a $1 trillion “border adjustment” tax on imports that the president hasn’t entirely embraced.

Democrats, meanwhile, have argued that the White House plan looks geared toward benefiting the wealthy and that Medicare and Social Security would get hurt as individuals scramble to reorganize their businesses and avoid paying the taxes that fund such programs.

“With this 15 percent pass-through, hedge fund managers, corporate lawyers and big business CEOs who make millions of dollars every year would pay 15 percent, while their workers will pay 20, 25, 30 percent,” Senate Minority Leader Charles E. Schumer, New York Democrat, said in a recent floor speech.